Final salary pensions

A final salary pension is a totally different animal to a personal pension, even if the end goal of providing income for your retirement is exactly the same. The rules that surround them, the level of flexibility and ownership on offer and, crucially, who is taking the investment risk are all different.

These days many final salary pensions look very generous in terms of the income guarantees they provide. This has led to them being seen as increasingly unaffordable by employers, with many companies that used to offer them closing their schemes to new members.

Final salary pensions

Final salary pension principles

  • Your employer normally takes a proportion of your gross pay (so you don’t pay tax on these contributions) as a contribution into the final salary scheme
  • The amount of money you get to enjoy from your pension in the future depends on how long you have worked for the company, and your salary on leaving / at retirement
  • You own a promise from your employer to pay you a certain income for life when you retire, and the scheme rules will tell you how and when you can take this
  • Unless you transfer away to a personal pension (thus losing the guarantees on offer) you don’t actually own a pension ‘pot’ and so cannot gift your pot to someone else when you die
  • The investment risk is your employer’s. You don’t have to worry how they do it, it is simply their problem to find the money to pay your promised retirement income.
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Funded or unfunded?

When the government introduced the pension freedoms from April 2015 it presented them with both an opportunity and a problem. The opportunity being people taking out more of their pensions earlier and injecting that money into the economy, which was good for HMRC’s tax take.

The problem was that the government are also one of the biggest providers of final salary pensions (to nurses, teachers, civil servants and so on). Many of these pensions are actually paid out of that year’s tax take so there isn’t actually an invested pot of money to raid. So they are “unfunded”.

If the government allowed people with unfunded schemes to take more money earlier, then HMRC’s overall tax take would go down and not up. So they simply changed the rules to stop this from being possible. The upshot being if you have an “unfunded” government scheme then you can’t transfer it to a personal scheme.

To find out more about funded and unfunded final salary pensions, follow the links below. Of course if you already know which type you have, you can just jump straight to it. 

If you have a “funded” final salary pension then there are a host of regulations and safeguards protecting your promised income. This includes the Pension Protection Fund that steps in to provide a (capped) income to you based on your promised income should your employer scheme fail.

With an “unfunded” scheme the government is basically responsible for paying you, and if the government fails completely then we are all in trouble.

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